Financial independence roadmap: Your personal balance sheet

The road to financial independence is different for everyone, but the starting point is that you need to organize your financial information. A personal balance sheet will help you see the full picture.

This document is critical for making decisions throughout your life. It’s a useful tool to grow your net worth as you move toward financial independence — the point at which you have enough assets to live comfortably in retirement and provide for your heirs.

The process of creating a personal balance sheet often uncovers opportunities and identifies risks to address — whether today, tomorrow, or 10 years from now. Having one document that identifies all assets, liabilities, ownership, and beneficiaries will go a long way toward streamlining your estate for future heirs. Here’s how to use your personal balance sheet to start creating a stronger financial future.

Identify risks and opportunities

Your balance sheet brings context to decisions. It allows you to understand how a decision in one part of your financial life affects other parts of your financial life. Estate planning, investment management, insurance, and tax should be handled in a coordinated manner to find opportunities and uncover risks. For example, if you focus too heavily on a tax reduction strategy, you might overlook the risk of a concentrated equity holding; seeing all your financial information in one place will reduce the chance of costly mistakes like this.

The goal is not just to mitigate risk but also to determine how to maintain and grow your wealth. Ask yourself, “Does this plan, strategy, or decision positively or negatively affect my long-term net worth?” Sometimes, it’s okay to pay taxes now if it positions you better going forward. Plus, in an era of uncertainty on the estate tax front, it’s crucial to know if and how proposed legislation will impact what the next generation will inherit.

The goal is not just to mitigate risk but also to determine how to maintain and grow your wealth.

The balance sheet is a starting point for identifying potential gaps in your investment strategy from a portfolio perspective. For example, some individuals view diversification as holding accounts in many places. After preparing a balance sheet, they may find that all these accounts are invested very similarly. It helps to diversify your investments, thereby significantly reducing your portfolio volatility.

Align your personal goals with your financial resources

A balance sheet can also provide key insights into your overall financial independence and help identify the best resources to use for cash needs. By understanding the balance of liquid and illiquid assets, you can more appropriately budget for your lifestyle needs and use various assets to their highest potential. 

In practice, this might be using a 529 savings account to ensure the most tax-free growth for college-related expenses or using a combination of Traditional and Roth IRA accounts to manage taxable income as tax brackets change with proposed legislation. For charitably inclined families, effective use of charitable accounts can result in substantial tax savings during high-income years while allowing a donor to gift assets over time. Whatever the case, a balance sheet can help you define or track progress toward achieving your goals and make informed decisions about the strategies you use to shape your financial future.

Consider your estate and legacy

When it comes to estate planning, it’s very difficult to create a holistic plan without a clear view of net worth and ownership. Often, advisors make mistakes by taking a myopic view, assuming the investment portfolio is the largest family asset. This is common with business owners. Ignoring assets outside of traditional investment portfolios leads to poor planning and the potential risk of unnecessary estate tax.

Consider this: The number-one legacy people most want to leave isn’t financial assets but family harmony. People don’t always realize how certain assets they cherished during their lifetime — family cottages, for example, or sentimental family heirlooms — may cause tension and frustration when they’re no longer around.

Consider this: The number-one legacy people most want to leave isn’t financial assets but family harmony.

The same can be true of family businesses when some family members are actively involved and some aren’t, or succession plans between unrelated parties aren’t documented appropriately. Having appropriate buy-sell coverage is important, along with thoughtful planning, to eliminate or at least reduce the possible loss of family harmony.

Next steps

There are two phases to creating a personal balance sheet: gathering the data and assembling it into a usable format. Gathering the data can be challenging, especially if you’re doing it for the first time. The most difficult part of the balance sheet can be determining the ownership of individual assets, particularly if someone hasn’t reviewed an asset in a long time. For example, people often make decisions during a marriage regarding titling that go unchanged after a divorce.

Developing the balance sheet is critical, but it’s even more important to review it regularly and keep it current with assistance from trusted advisors. If you have questions or need assistance putting yours together, contact us today. Our advisors are ready to help.